Kamikaze Economics with Slow-Motion Debt Crash

Wee bit of Contagion? Catalonian default will be seen as Spanish default: Moody’s

“An impending train crash.” Those are the words increasingly being used to describe Madrid’s seemingly intractable conflict with Spain’s separatist north-eastern region of Catalonia. The latest flashpoint in tensions is the political show trial of Catalonia’s former president, Artur Mas, and two other Catalan politicians for their role in organizing a purely symbolic, non-binding referendum on national independence in November, 2014.

Mas has been charged with serious disobedience and other crimes for ignoring a court injunction against the unofficial vote, which the central government in Madrid considered illegal. If found guilty he could be barred from public office for up to ten years.

For Catalonia’s separatist movement, the trial has provided yet another PR coup just as popular support for the movement was beginning to wane. Once again, the outside world is being reminded, no matter how briefly, about the region’s national aspirations and the central government’s increasingly repressive efforts to thwart them.

Upping the Ante

Apart from the estimated 3,000 Catalan-based companies that have upped sticks for other parts of Spain, particularly Madrid where business taxes are lowest, the political tensions and uncertainty have had limited direct repercussions on Catalonia’s macro-economy.

The local economy is performing far more robustly than it was two or three years ago, with its GDP growth outperforming the national average, unemployment falling and tourist numbers once again breaking historic records: in 2016 Catalonia drew 18 million visitors, 4% more than the previous year. That’s nearly two and a half times its permanent population and almost a quarter of the total number of tourists that visited Spain last year.

But that could be about to change, what with the simmering war of words and gestures once again reaching fever pitch. As Artur Mas faces the prospect of prosecution for organizing a symbolic popular consultation, his successor, Carles Puigdemont, by all accounts a more committed separatist than Mas, is planning another referendum — one that was initially scheduled for September but which could be brought forward to as early as May.

“If 50% plus one vote ‘yes’, we will declare independence without hesitation,” he said in his New Year address.

For its part, Madrid insists that no such vote will be allowed to happen. It has repeatedly threatened to trigger article 155 of Spain’s constitution, which would allow it to effectively suspend Catalonia’s regional autonomy. It has also fined the two main civil organizations pushing for Catalonian independence, the National Catalan Assembly and Òmnium Cultural, hundreds of thousands of euros for their part in the last referendum.

More ominous still, when Spain’s defense minister until last November, Pedro Morenes, was asked what the army would do if Catalonia organized another consultation, he avoided giving a direct answer: “If everyone does what they are legally bound to do, that situation will not be necessary.”

A Slow-Motion Debt Crash

In the absence of any hope of a negotiated settlement, tensions are sure to rise. For the semi-recovering economies of both Catalonia and Spain, that could be very bad news. Despite representing one-fifth of the national economy and being a significant net provider of funds to Madrid’s coffers, Catalonia can no longer issue its own debt and depends on the central government’s national liquidity fund (FLA, for its Spanish acronym) for about 60% of its funds.

As ratings agency Fitch warned in April last year when it sent Catalonian debt even deeper into junk territory, the region has grave liquidity problems that will require “proactive management” and “close collaboration with the central state ” — something that’s clearly not on the cards any time soon.

Standard & Poor’s cautioned that Catalonia’s management of its short-term risks “represents a much greater risk” than previously thought and it has “serious doubts about the region’s ability to cope with the short-term liquidity pressures it faces.”

This week Moody’s raised the pressure even further when it reminded the Spanish government (and investors in its ridiculously low-yielding debt) that any default on Catalonia’s debt would be interpreted by the markets as a Spanish default. In other words, whence goeth Catalonia, goeth Spain.

Moody’s analyst Marisol Blázquez told Europa Press that the political tensions are reflected in Catalonia’s current rating of ‘Ba3’ (negative outlook), the lowest of all of the ten Spanish regions Moody’s evaluates. “This rating is four notches higher than it would be if it weren’t for the State’s support. If that support wasn’t there, the rating would be not be ‘Ba3’; it would be ‘Caa1′”, Blázquez added. In other words, deep junk.

Kamikaze Economics

What most preoccupies Moody’s is the extent to which “the political situation could impact the fiscal situation,” said Blásquez. In the last eight years Spain’s public debt has ballooned from 39.4% of GDP to 99.3%.

Even with historically low interest rates (gracie, Signor Draghi), the price of servicing government debt can get out of control. Between 2011 and 2015 Spain’s central government spent €121 billion – the equivalent of 12% of annual GDP – on interest payments. And still, the debt mountain grows, particularly at the regional level. In 2015 two out of every three euros of new debt created went to the regions.

In an effort to rein in this spending the central government recently created a group of experts with analysts representing each region to study how best to reform Spain’s system of regional finance. Last week the group met for the first time. Each and every region dispatched its representatives, except for one: Catalonia.

And that’s the rub: the more relations sour between Madrid and Barcelona, the less likely they are to see eye to eye on fiscal matters and the greater the chances that Catalonia’s — and by extension, Spain’s — financial situation spirals out of control. Ultimately, Madrid may have the upper hand in this battle of wills, but Catalonia has a strong card up its sleeves: its tick-tocking debt load. And as Catalonia’s vice president, Oriol Junqueras, warned Spain’s foreign creditors and bondholders during a speech in Brussels three years ago, if backed into a corner, it wouldn’t hesitate to use it. By Don Quijones.

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14 comments for “Kamikaze Economics with Slow-Motion Debt Crash”

Kasadour

Feb 11, 2017 at 1:08 pm

If Catalonia’s GDP growth is outperforming the national average, unemployment is down, tourism is thriving, et cet er cet, great! It sure sounds like Spain needs Catalonia far more than Catalonia needs Spain. So screw the “central state”, but not without plenty of bloodshed, which nobody can put a price on. Somebody always wants to be a president!

Toad

Feb 11, 2017 at 7:18 pm

Disagree regarding the “plenty of bloodshed” prediction.

A *bloodless* and orderly separation of Catalonia from the Spanish state is more than conceivable. A bloodless Brexit will be a macro version of Catalonia’s micro.

nick kelly

Feb 11, 2017 at 9:34 pm

You do know that Spain had very nasty civil war, with Catalonia I believe on the losing side?
So did Greece- 46 -48.

They are probably both heading for a replay if the economy collapses

The Duke of Wellington,who raised the insurrection in Spain, then ruled by Napoleon, advised against encouraging civil war because it was even nastier than war between countries.

Kasadour

Feb 11, 2017 at 10:12 pm

Which was captured beautifully by Picasso in Guernica. Hope for a much better outcome.

nick kelly

Feb 12, 2017 at 1:24 am

I think Guernica was the first use of aircraft against civilians.
Or to be technically correct- the first use of heavier- than- air aircraft because the Zeppelin raids on London were first.

nick kelly

Feb 12, 2017 at 10:02 am

I’m told by friend who lived in Spain that the Civil War ending 1937? is still not often discussed in social situations.

Tom Kauser

Feb 11, 2017 at 2:27 pm

We are going to need to have your people forfeit and admit Democratic rule isn’t a strength?

Where’s the gold?

Tom Kauser

Feb 11, 2017 at 2:30 pm

Takes the gold Strictly for safe keeping!

Don Quijones

Feb 12, 2017 at 10:33 am

Nick Kelly, your friend is right: the civil war, which ended (at least officially) in 1939, (not ’37), is rarely discussed in social situations. In fact, when Franco died and Spain’s half-baked transition to democracy began, in the late seventies and early eighties, the country as a whole more or less agreed to forget about all the terrible things that had transpired, not just during the Civil War but also the 40-year dictatorship that followed it.

As a result, Spain, as a living, breathing whole, is like a deeply disturbed individual haunted by a massive childhood trauma. But instead of facing the source of the trauma head-on, the people have buried it in the deepest, darkest recesses of their collective subconsciousness, where it continues to fester to this day — a subject I covered in some depth in my 2013 article Fear, Loathing and Collective Amnesia in Crisis-Ridden Spain (link: https://riggedgame.blog/2013/09/19/fear-loathing-and-resurrected-ghosts-in-spain/).

nick kelly

Feb 12, 2017 at 6:33 pm

Good read. Incredible re: idea of bombing Barcelona. I didn’t know it was THAT bad.

kiwiinCanada

Feb 12, 2017 at 6:19 am

My larger concern is if the Euro zone as a whole begins to disintegrate. The substantial amount of sovereign debt accumulation encouraged by ECB bond purchases and low to negative interest rates can be addressed in two ways each with their own unhappy consequences. The debt can be converted to local currencies before the inevitable devaluation in which cases the losses are carried by the parties which hold the debt on their balance sheet. For the most part I believe this to be euro zone banks and the ECB. The second scenario is that the devaluation occurs and the euro debt is repriced at a much less favourable exchange rate to the new national currency. This leaves the sovereigns involved with very much deteriorated balance sheets. Perhaps these various scenarios, if they have any justification, are part of the glue which holds the euro zone together but given the political trends they can’t be ruled out.

Quadra

Feb 12, 2017 at 4:33 pm

Agree but learned that 80 percent of French public debt is issued under French law. So if you change the law u can pay it with the new French francs.i.e convert the bonds to FRF and pay in Devaluated FRFs. That’s Le Pens plan.
I guess biggest issue is how do you block capital flight before it’s all implemented

robt

Feb 12, 2017 at 5:32 pm

If I understand you, the scenario you describe seems to envision the simultaneous rather than a progressive collapse of the Euro system. If a progressive withdrawal of nations from the Euro (the most likely prospect), the bonds would still be payable in euros, the original denomination of the contract, as is the case with all contracts, mortgages, etc. To convert the bonds to a newly created local currency would be a default.
Imagine all the banana republics in the world that would love to convert their US dollar debt to their local currency, and how many actually do so – none. Alternatively, they just default, viz Argentina 2001.
Also, there would not necessarily be an ‘inevitable’ devaluation of the [new local currency]. With (the possibility of putting) their economic house in order there could well be an appreciation of the local currency relative to the euro, especially if more countries abandon the euro.
Anyway, the problem is solved by hedging. If you (i.e. any issuer) have to pay Euro in the future to redeem your bonds at maturity, go long the Euro to match your exposure for zero risk, but with an expense for fees.

nick kelly

Feb 13, 2017 at 6:59 pm

A Greek drachma, Italian lira, Spanish peso might appreciate?

Stand alone, all experience at least a tripling of interest rates.
All that prevents (at the moment) the collapse of all three’s banking systems is the backing (and to shorts, the threat) of the big gun- the ECB.
If they do want to strike out on their own- fix the economy first.